News & Events

Hong Kong - Taxation of Hedge Funds October 2002 | Ray Heath, SCMP

Hong Kong wants more fund managers. It's in danger of having
fewer if the threat of taxation now hanging over the industry
is not removed soon. Threats of an exodus to Singapore, Hong
Kong's traditional arch-rival in the battle to attract funds;
have been bandied around as the Inland Revenue continues to
circle the industry. Anxious managers have banded together,
backed by the Alternative Investment Managers' Association
in a bid to persuade the government to call the tax-man off
the industry.

For as long as anyone can remember offshore funds based in
Hong Kong have never been taxed. This follows the practice
in all major fund centres in the world. But while some have
their freedom from tax enshrined in legislation or practice
notes, Hong Kong has always run with a less formal arrangement.
If that were to end, offshore managers could find themselves
being presented with tax bills on their funds going back up
to six years.
"That would mean bankruptcy," said one lawyer involved
in the growing crisis.

The tax time-bomb appeared to have been defused as long ago
as May, several months after the tax man began to show what
fund managers regarded as an unhealthy interest in their affairs.
They became nervous late last year when the IR started requesting
reports on their earnings from funds that are incorporated
offshore, but are partly invested in local securities. Such
reports are usually followed up by tax demands, and could
have meant the funds paying the 16% corporation tax imposed
on all other companies in Hong Kong. This led to a flurry
of lobbing by fund managers, which appeared to have done the
trick.

In May, Hong Kong's Financial Secretary, Anthony Leung, publicly
reassured offshore fund managers that there were no plans
to tax them.
"We are aware of the fund industry's concerns arising
from recent actions by the Inland Revenue Department,"
Mr Lueng told a lunchtime gathering of managers. "I would
like to stress that these actions were triggered by availability
of new information about the identity of fund management companies."

Although there were sighs of relief, and a general conviction
that Mr Lueng had ended the matter, the Inland Revenue has
since continued to press funds for information. There has
even a dismaying rumour that one fund has been advised by
its lawyers to pay up. If that were the case, cry other managers,
a nasty precedent would be set. As Mr Lueng's reassurances
obviously never reached the Inland Revenue, the industry is
now looking for something stronger than a speech from the
financial secretary.

In November, contact was made with Tony Miller, former housing
director, now Permanent Secretary for Financial Services and
Treasury. Mr Miller, agree fund managers, is sympathetic.
He was asked to clarify, and solidify, the tax exempt status
of unauthorised funds in Hong Kong. Funds authorised by the
Securities and Futures Commission already enjoy tax breaks,
and one avenue of hope was that SFC could be persuaded to
change its code of practice on what are considered to be offshore
funds.

Mr Miller came back, asking for more detailed suggestions.
A group of fund managers got together, and by November another
letter was drafted by lawyers acting for funds, setting out
more detailed proposals and circulated for comments. Avoiding
the need for special legislation was regarded as crucial.

The Hong Kong government, while anxious not to scare away
a very promising industry as it fights to re-invent the economy,
is concerned that it should to be seen to be handing out favours
in troubled times. When serious suggestions are being made
to tax domestic helpers to help fund the government's burgeoning
deficit, introducing legislation which would favour "rich'
fund managers could be political dynamite.
"The government has been wondering whether legislative
action would be successful and whether they really wanted
to fight it out in Legco, so we came in with suggestions about
that," said a manager close to the affair.

The government has indicated that they are now actively looking
at the problem, and would like to have the matter resolved
by the time the annual budget is introduced in March. It might
not be that easy. While senor officials are keen to have the
issue go away, and fund managers to stay, they are not as
familiar with the technical issues that might be involved
in confirming offshore funds' tax exempt status. This could
mean a solution could be moved much further down the road
as all the relevant issues were addressed. The big fear is
that, meanwhile, the Inland Revenue will start issuing tax
demands. This would put the funds in a nearly impossible position.
Auditors would insist that provisions were set aside for the
payments. That money would come from earnings, which have
been depressed by the slow state of markets. The demands take
in the good years from the good years, so managers could find
themselves in deficit. Worse, clients would be scared off.
As one manager argued, the 16 per cent tax charge would to
have been added to the expenses, so reducing returns on the
funds. "That would mean their performance would instantly
lag 16 points behind that of rivals in the US, Britain and
Singapore. Who is going to put money with a fund which automatically
is 16 points behind the game?" Some funds are pushing
for swift action to head off the tax man. Suggestions include
issuing a practice note which would prevent those pressing
claims.

Some militants believe the Financial Services Bureau, which
is also supposed to promoting Hong Kong as a money magnet
for managers industry, is not taking the issue seriously enough.
"The FSB would like us believe that when Anthony Leung
made his statement, that was the end of the matter. But it
was so woolly, and the Inland Revenue had nothing to do with
it. They are the hounds that have to be called off,"
stated one irate manager for major international fund group.

Much of the lobbying has been done by the alternative investment
managers, and there are some who feel the long-only community
has not done enough to support the cause.
"It's annoying because hedge funds are not the area most
affected. Private equity funds, mezzanine funds, all unauthorised
funds are involved. The frustrating thing is that there are
many members of the community who don't want to understand
this, and are not terribly bothered," complained one
activist.

If a swift solution is not found, and the Inland Revenue
goes ahead, warns many managers, the whole industry and the
economy will suffer.
"It's the easiest thing in the world to shift the money
down to Singapore - just the touch of a button."

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